Here is part I:

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Technorati Tags credit crisis, deflation, Economic Indicators, Economics, housing, Housing Market, Inflation, investing, markets, monetary policy, Risk, subprime

For some of the best and most insightful financial writing around I recommend combing through his archives. I occasionally do. Revisiting past musings of the greats may not be as immediately useful as some things, but longer term it allows a perspective that will serve you well over time. distributed raman amplifier

One view of the Japanese stimulus (or multiple stimuli) is that it (they) failed because it was (they were) too small. Just as the reason that in World War I all British attacks prior to the Battle of the Somme failed was because they were too small.

Technorati Tags Arnold Kling, Economics, Japan, quotes, World War I

Therefore it is no surprise that it is a larger story in Baton Rouge than elsewhere. Anyway, The Baton Rouge Business Report’s (as fine a local business publication as there is in the United States) Olivia Watkins interviewed me on how those of us in the industry viewed the impact and fallout from this. It was a long discussion, but some of my thoughts on how this kind of thing has played out in the past made it into this story.

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Click for larger version of charts.

Technorati Tags economy, Employment, New York Times

The bank will use leveraged loans and commercial mortgage- backed debt, some of the securities blamed for generating the worst financial crisis since the Great Depression, to fund executive compensation packages, people familiar with the matter said. The new policy applies only to managing directors and directors, the two most senior ranks at the Zurich-based company, according to a memo sent to employees today.

I love it. If they go up the execs get a big payoff. If they don’t, at least they are off the banks books.  Cash is preserved, the balance sheet strengthens.

Technorati Tags Credit Suisse, leveraged loans, management compensation, mortgage securities

The cure for our housing crisis is prices coming down and all the pain that comes with it. Making them “affordable” through extra low interest rates just creates a new crisis down the road.

Technorati Tags Charlie Mayer, debt crisis, Glenn Hubbard, housing crisis, Housing Market

The peak in 2000 marked an unprecedented 160% overshooting of the trend, which is double the overshoot in 1929. The index has been above the trend for 17 years. We also see that the major troughs saw declines in excess of 50% below the trend. If the S&P 500 were sitting squarely on the regression, it would be hovering around 820. If the index should decline over the next 12 months to a level comparable to previous major bottoms, it would fall to the vicinity of 400-425.

That is a teeny bit lower than how I see it, but it is about right. However, he provides a chart which adjusts for inflation using John Williams’ shadow government stats. That shows the markets at all time lows. You can see and read the rest here.

I have one problem with that analysis. While I do think some adjustment might make it look a little better, if John Williams’ numbers are correct then stocks should be as low as they are because GDP and earnings have been horrible in inflation adjusted terms for a very long time. We have been in a recession for two decades similar to Japan. I don’t think that is true, but if so then stocks deserve every bit of the undervaluation they have experienced.

I’ll stick with the first graph being slightly overstated. It should be noted that statisticians would likely have problems with the while idea of the long term regression line having any meaning. I disagree, there are fundamental economic reasons the line makes sense as an approximation. I won’t go into the details now, I just want it noted I am aware of the issue.

Hat tip: Barry Ritholtz.

Technorati Tags chart, mean, regression, stock market, Valuation

Technorati Tags Automobile Industry, bailout, banks, Big Three, Hank Paulson, Treasury

The sad thing is that it isn’t only “liberal” economists, it is the meat of the profession and plenty of so called “conservative” politicians.

Hat Tip: McQ

Technorati Tags Barack Obama, Economics, economy, fiscal stimulus, Fred Thompson, Humor, Politics

Here is a nice collection of charts based on Robert Shiller’s data. First, the really long term:

For those who haven’t been here before the housing category and tag has lots more on the bubble. My thoughts on the latest data, and that in reality this is long term a good thing, can be found here. A key point to remember is that every bubble, regardless of the asset, not only has corrected, but generally over shoots. This implies a long way to go, and for several more years before inflation adjusted prices actually rise.

Here is one of more recent years:

Thus, if history is a guide, we should see an inflation adjusted fall in prices of about 35% lower than here, or at least 25% in nominal terms.

You can find charts for individual metro areas as well by going here.

Hat tip: Les Jones via Instapundit

UPDATE: Over at Les Jones place a commenter asked for the price relative to income. Ask and you will receive. Thanks to Calculated Risk I have a number of charts with various ways to plot the price of housing. As a note the Case Shiller index adjusts for changes in the size of houses over time (each chart can be clicked for a larger version.) Here is the price to income chart:

Using this metric a combination of rising incomes and/or falling prices are needed to close this gap of about 15%. That assumes no overshoot, and of course in a recession incomes tend to not rise much.

Another useful way to look at it is the price to rent ratio.

By this measure about another 20% to go. Here are three of the hardest hit areas:

By this measure Miami has gone about 80% of the way to the eventual bottom, Los Angeles about 65%, and New York just over 40%.

Here is the fall from the peak for all 20 metro areas covered by the Case-Shiller index:

How is this likely to impact consumption? Here is a frightening graph which bodes poorly for the shift in spending (or positively since we need to save more over the long term.)

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Technorati Tags Case-Shiller, charts, housing, housing data, Robert Shiller

HT: James Dailey

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We keep hearing about positive signs month after month, but the latest data on the housing markets shows the pace of declines has been accelerating and widening, not slowing down.

In my opinion this is good. The decline in prices of overvalued assets is a good thing, whether houses, stocks or debt. The problem has been overvalued assets, the cure is lower valuations. it is uncomfortable (to say the least) if you hold those assets and assumed their prices would stay high, but the price of them staying high was huge. Decades of low returns, unstable asset markets from even more outrageous pricing levels (making the eventual correction even worse) an inability for savers to profitably put money to work without taking on enormous risk and housing prices straining the ability of consumers to rationally house themselves (and leading to a need for more debt to maintain standards of living.

This highlights that the amount of debt which will need to be written off or through government fiat (and lots of cash) magically made good is still nowhere near finished. My long standing estimate of 1.2 trillion in writedowns now looks positively quaint, when a year ago I was considered a fear mongerer. So far our government has deployed over 7.7 trillion to try and paper over this disaster. The ultimate likely losses from all manner of debt to financial intermediaries (whether or not they are recognized or disguised by the government balance sheet) is climbing way past 2 trillion and the ceiling on that number is very hard to confidently set:

“All three aggregate indices and 13 of the 20 metro areas are reporting new record rates of decline. Looking at the returns of the U.S. National Index, prices are back to where they were in early 2004. As of September 2008, the 10-City Composite is down 23.4% from its peak, the 20-City Composite is down 21.8% and the National Composite is down 21.0%.”

I still believe the Case-Shiller index will decline at least 35% peak to trough, and adjusted for inflation will bottom out around 50% from its all time peak before all is said and done. From Barry Ritholtz:

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Technorati Tags Case-Shiller, credit crisis, Housing Market, Valuation

As one of the few who saw this crisis coming and how it might play out across the board, not just in particular areas, he deserves a listen. As one of the most successful investors of the last 30 years he would warrant a listen anyway.

Watch the whole thing.

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Technorati Tags Asset Allocation, credit crisis, Emerging Markets, equities, Housing Market, investing, Jeremy Grantham, Risk, value investing

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You can take a look at what the bottoming process has looked like for all the bear markets since WWII here. Hat tip: Calculated Risk.

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Technorati Tags Bear markets, crash of 1929, great depression, market bottoms, Oil Crisis, tech bubble

We’re currently at a P/E around 14, a bit below the historical long-run average P/E of 16.3, meaning you could expect a slightly above-average return from buying stocks now. Specifically, if companies were to pay their shareholders all the income to which they’re entitled in the form of a dividend, that dividend would give you better than a 7% immediate return, and over the long run, the dividend would grow at least at the rate of inflation. That’s a return that proved more than sufficient compensation to investors for the extra risk they faced from stocks over the last century and a half, which included plenty of times tougher than those we’re going through at the moment. To me, a 7% real yield sounds like an attractive investment, despite the risk, and certainly dominates most other alternatives as a long-run vehicle for saving for retirement.

I agree with that, though I think most people would be surprised that attractive pricing means only a 7% yield plus inflation. In dividends are actually likely to grow 1-2% faster than inflation. Unfortunately we do not get all of that real yield because companies retain far more of their real dividend than necessary and do not distribute it to their shareholders. Much of that retained dividend is wasted. which brings me to a point of disagreement:

But isn’t it possible that the P/E will decline further, to much below the historical average, before the carnage is finished? Sure it is. But here’s another way to look at that. Companies in fact don’t turn over 100% of their profits to the shareholders as dividends, but re-invest some of those profits in the hope that future earnings will increase faster than inflation. The typical stock in the S&P 500 today is giving you a 3% dividend, which you could hope will grow 3% faster than inflation over the long run as a consequence of the reinvested profits. That again to me sounds like a very nice investment. You can buy and hold for the long term with the philosophy that it’s that stream of growing dividends that you really want and are going to get. Let the market price of the stock go up or down from here wherever the psychology of the market may take it– you’ve still received what you paid for, and it’s a reasonable deal.

Loner term those reinvested profits grow only a bit faster than inflation and trail GDP growth. Long term it is only about 1-2% above inflation. So, 3% plus 1-2% plus inflation gives us 4-5% above inflation. Still reasonable, but hardly spectacular. Of course payouts could rise and increase the dividend yield without reducing growth. So 4% dividend yield, plus 2% (let’s be optimistic) and 3% inflation. That is 9%. With some appreciation in the P/E ratio returns could be higher, perhaps substantially so.

The rest of the post is pretty good for someone who wants to invest themselves, needless to say we believe we can, and have, do much better. Not because of stock picking prowess, but asset allocation decisions, especially hedging against risk or avoiding it in many situations. The graph above over the past few years shows why that can be pretty effective. Nevertheless, sound advice.

John Hussman gives a very good way to look at the opportunities and risks in the current market as well, and some sound advice about approaching this with a long term focus but careful attention to the risks. Investing now does offer good long term returns, but you may be able to do better later. Some exposure is certainly warranted and John gives a good explanation as to why. Known by many inaccurately as a “Perma Bear” he is certainly no mindless cheerleader.

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Technorati Tags investing, Jim Hamilton, Robert Shiller, S&P 500, stocks, Valuation

Instead let us look at what expectations for them are now. From Citigroup (pdf.)

What we see here is that expectations for profits and loan growth are far higher than past crises show are likely. The question we have to ask is whether it is as bad as those past events? I don;t know, but if it is as bad as it appears expectations are still too high.

Key points:

Earnings (of course) collapse, driven in part by soaring bad debts. However, these periods also suffer massive shrinkage in loan books and (more modest) shrinkage in deposits and total balance sheets. Pre provision operating profit also tumbles, in part reflecting this balance sheet shrinkage. Applying even the least damaging of these episodes (Hong Kong 1997-2002) to the current sector would see loan books halve and earnings, equity and operating profit all fall c40% from current forecasts.

[...]

To be clear, none of our economists forecast depression or deflation in Europe, but as recent IMF analysis demonstrates, recessions preceded by financial crisis tend to be long and deep. We might find ourselves rereading this report in a few years time and thinking that we were way too bearish to even raise this spectre. Or we might not.

My suspicion is that the specific problems mentioned earlier make these outcomes far more likely than many people wish to admit.

Hat Tip: Alphaville

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Technorati Tags banks, Citigroup, debt, deflation, European banks, Financial crisis, loan growth

The resentment, irritation, condescension and, at times, outright hostility to my Cassandra act makes me wish I had a video of my own. Sigh…

Oh well, it pays to remember that Cassandra was right. I was never as sure of myself as Peter, but risk management isn’t about knowing you are right, but knowing what could go wrong and whether it is likely enough to act upon.

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Technorati Tags credit crisis, financials, investing, Peter Schiff, Risk

This has fortunately not been an issue for clients at our firm, as losses have been relatively small to non-existent. However, it has been an issue for the many folks looking to become clients. We are having to approach this carefully and with some sympathy.

They want to work with us because we have avoided the carnage. Those most likely to be looking our way have suffered a great deal. We are looking at it on a case by case basis. At minimum we can give them some good advice about next steps, even if we are not going to have an ongoing relationship.

In essence we need to step up to the plate even though we cannot afford to take every potential client and make sure that people have what they need to move forward intelligently with or without our direct involvement.

Hat tip: Greg Mankiw

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